UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File No.: 000-51826

MERCER INTERNATIONAL INC.

(Exact name of Registrant as specified in its charter)

Washington		47-0956945
(State or other jurisdiction		(I.R.S. Employer
of incorporation or organization)		Identification No.)

Suite 2840, 650 West Georgia Street, Vancouver, British Columbia, Canada, V6B 4N8
(Address of office)

(604) 684-1099
(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months or for such shorter period that the registrant was required to submit and post such files). YES o NO o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer o		Accelerated Filer þ		Non-Accelerated Filer o		Smaller Reporting Company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO þ

The Registrant had 57,042,605 shares of common stock outstanding as at August 3, 2011.

 

 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

MERCER INTERNATIONAL INC.

INTERIM CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2011

(Unaudited)

FORM 10-Q
QUARTERLY REPORT — PAGE 2

MERCER INTERNATIONAL INC.

INTERIM CONSOLIDATED BALANCE SHEETS

(Unaudited)

		June 30,				December 31,
		2011				2010
ASSETS
Current assets
Cash and cash equivalents		€	151,795			€	99,022
Receivables			104,235				121,709
Inventories (Note 4)			104,316				102,219
Prepaid expenses and other			10,689				11,360
Deferred income tax			24,928				22,570
Total current assets			395,963				356,880
Long-term assets
Property, plant and equipment			824,060				846,767
Deferred note issuance and other			9,933				11,082
Note receivable			—				1,346
			833,993				859,195
Total assets		€	1,229,956			€	1,216,075
LIABILITIES
Current liabilities
Accounts payable and accrued expenses		€	112,598			€	84,873
Pension and other post-retirement benefit obligations (Note 7)			692				728
Debt (Note 5)			44,152				39,596
Total current liabilities			157,442				125,197
Long-term liabilities
Debt (Note 5)			708,895				782,328
Unrealized interest rate derivative losses (Notes 6 and 9)			41,069				50,973
Pension and other post-retirement benefit obligations (Note 7)			23,048				24,236
Capital leases and other			11,242				12,010
Deferred income tax			14,404				7,768
			798,658				877,315
Total liabilities		€	956,100			€	1,002,512
EQUITY
Shareholders’ equity
Share capital (Note 8)			228,762				219,211
Paid-in capital			(5,609	)			(3,899	)
Retained earnings (deficit)			32,480				(10,956	)
Accumulated other comprehensive income (loss)			34,715				31,712
Total shareholders’ equity			290,348				236,068
Noncontrolling interest (deficit)			(16,492	)			(22,505	)
Total equity			273,856				213,563
Total liabilities and equity		€	1,229,956			€	1,216,075

Commitments and contingencies (Note 10)
Subsequent event (Note 11)

The accompanying notes are an integral part of these interim consolidated financial statements.

FORM 10-Q
QUARTERLY REPORT — PAGE 3

MERCER INTERNATIONAL INC.

INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Revenues
Pulp		€	217,274			€	228,293			€	427,732			€	399,414
Energy			13,941				11,931				27,618				21,062
			231,215				240,224				455,350				420,476
Costs and expenses
Operating costs			172,535				168,275				335,890				308,684
Operating depreciation and amortization			13,869				14,106				27,945				27,830
			44,811				57,843				91,515				83,962
Selling, general and administrative expenses			8,632				9,955				18,862				18,050
Purchase (sale) of emission allowances			(32	)			—				(202	)			—
Operating income (loss)			36,211				47,888				72,855				65,912
Other income (expense)
Interest expense			(14,883	)			(16,898	)			(30,789	)			(33,321	)
Investment income (loss)			136				117				463				211
Foreign exchange gain (loss) on debt			342				(9,371	)			1,453				(14,602	)
Gain (loss) on extinguishment of debt (Note 5)			—				—				—				(929	)
Gain (loss) on derivative instruments (Note 6)			(2,339	)			(4,462	)			9,904				(11,008	)
Total other income (expense)			(16,744	)			(30,614	)			(18,969	)			(59,649	)
Income (loss) before income taxes			19,467				17,274				53,886				6,263
Income tax benefit (provision) — current			(1,478	)			(1,319	)			(2,297	)			(1,523	)
— deferred			(2,140	)			—				(2,140	)			—
Net income (loss)			15,849				15,955				49,449				4,740
Less: net loss (income) attributable to noncontrolling interest			(1,466	)			(3,554	)			(6,013	)			115
Net income (loss) attributable to common shareholders		€	14,383			€	12,401			€	43,436			€	4,855
Net income (loss) per share attributable to common shareholders (Note 3)
Basic		€	0.32			€	0.34			€	0.97			€	0.13
Diluted		€	0.26			€	0.23			€	0.77			€	0.11

The accompanying notes are an integral part of these interim consolidated financial statements.

FORM 10-Q
QUARTERLY REPORT — PAGE 4

MERCER INTERNATIONAL INC.

INTERIM CONSOLIDATED STATEMENTS OF RETAINED EARNINGS (DEFICIT)

(Unaudited)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Net income (loss) attributable to common shareholders		€	14,383			€	12,401			€	43,436			€	4,855
Retained earnings (deficit), beginning of period			18,097				(104,781	)			(10,956	)			(97,235	)
Retained earnings (deficit), end of period		€	32,480			€	(92,380	)		€	32,480			€	(92,380	)

INTERIM CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)
(In thousands of Euros)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Net income (loss)		€	15,849			€	15,955			€	49,449			€	4,740
Other comprehensive income (loss), net of taxes
Foreign currency translation adjustment			(864	)			(4,688	)			2,600				2,944
Pension income (expense)			127				(234	)			403				(600	)
Unrealized gains (losses) on securities arising during the period			(6	)			12				—				18
Other comprehensive income (loss), net of taxes			(743	)			(4,910	)			3,003				2,362
Total comprehensive income (loss)			15,106				11,045				52,452				7,102
Comprehensive loss (income) attributable to noncontrolling interest			(1,466	)			(3,554	)			(6,013	)			115
Comprehensive income (loss) attributable to common shareholders		€	13,640			€	7,491			€	46,439			€	7,217

The accompanying notes are an integral part of these interim consolidated financial statements.

FORM 10-Q
QUARTERLY REPORT — PAGE 5

MERCER INTERNATIONAL INC.

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Cash flows from (used in) operating activities
Net income (loss) attributable to common shareholders		€	14,383			€	12,401			€	43,436			€	4,855
Adjustments to reconcile net income (loss) attributable to common shareholders to cash flows from operating activities
Loss (gain) on derivative instruments			2,339				4,462				(9,904	)			11,008
Foreign exchange loss (gain) on debt			(342	)			9,371				(1,453	)			14,602
Loss (gain) on extinguishment of debt			—				—				—				929
Depreciation and amortization			13,929				14,176				28,067				27,997
Accretion expense (income)			289				514				759				945
Noncontrolling interest			1,466				3,554				6,013				(115	)
Deferred income taxes			2,140				—				2,140				—
Stock compensation expense			471				227				2,539				733
Pension and other post-retirement expense, net of funding			7				138				(7	)			332
Other			919				844				1,603				1,847
Changes in current assets and liabilities
Receivables			5,523				(28,798	)			12,700				(45,942	)
Inventories			(8,399	)			(5,724	)			(4,086	)			(10,983	)
Accounts payable and accrued expenses			(833	)			5,377				24,555				13,332
Other			485				687				844				(594	)
Net cash from (used in) operating activities			32,377				17,229				107,206				18,946
Cash flows from (used in) investing activities
Purchase of property, plant and equipment			(7,756	)			(14,542	)			(15,825	)			(20,392	)
Proceeds on sale of property, plant and equipment			27				162				380				549
Note receivable			375				579				771				495
Net cash from (used in) investing activities			(7,354	)			(13,801	)			(14,674	)			(19,348	)
Cash flows from (used in) financing activities
Repayment of notes payable and debt			—				—				(30,351	)			(8,250	)
Repayment of capital lease obligations			(638	)			(603	)			(1,493	)			(1,607	)
Proceeds from borrowings of notes payable and debt			—				840				—				840
Proceeds from (repayment of) credit facilities, net			—				5,550				(14,652	)			5,550
Proceeds from government grants			4,837				1,144				8,949				10,559
Net cash from (used in) financing activities			4,199				6,931				(37,547	)			7,092
Effect of exchange rate changes on cash and cash equivalents			(668	)			3,094				(2,212	)			4,164
Net increase (decrease) in cash and cash equivalents			28,554				13,453				52,773				10,854
Cash and cash equivalents, beginning of period			123,241				48,692				99,022				51,291
Cash and cash equivalents, end of period		€	151,795			€	62,145			€	151,795			€	62,145

The accompanying notes are an integral part of these interim consolidated financial statements.

FORM 10-Q
QUARTERLY REPORT — PAGE 6

MERCER INTERNATIONAL INC.

INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(Unaudited)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Supplemental disclosure of cash flow information
Cash paid (received) during the period for
Interest		€	23,406			€	14,604			€	29,920			€	29,033
Income taxes			35				(37	)			336				29
Supplemental schedule of non-cash investing and financing activities
Acquisition of production and other equipment under capital lease obligations		€	(37	)		€	318			€	273			€	530
Decrease (increase) in accounts payable relating to investing activities			6,321				(2,720	)			6,376				(3,703	)

The accompanying notes are an integral part of these interim consolidated financial statements.

FORM 10-Q
QUARTERLY REPORT — PAGE 7

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1. The Company and Summary of Significant Accounting Policies

Basis of Presentation

The interim consolidated financial statements contained herein include the accounts of Mercer International Inc. (“Mercer Inc.”) and its wholly-owned and majority-owned subsidiaries (collectively the “Company”). Mercer Inc.’s shares of common stock are quoted and listed for trading on both the NASDAQ Global Market and the Toronto Stock Exchange.

The interim consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”). The year-end consolidated balance sheet data was derived from audited financial statements. The footnote disclosure included herein has been prepared in accordance with accounting principles generally accepted for interim financial statements in the United States (“GAAP”). The interim consolidated financial statements should be read together with the audited consolidated financial statements and accompanying notes included in the Company’s latest annual report on Form 10-K for the fiscal year ended December 31, 2010. In the opinion of the Company, the unaudited interim consolidated financial statements contained herein contain all adjustments necessary to fairly present the results of the interim periods included. The results for the periods included herein may not be indicative of the results for the entire year.

The Company has three pulp mills that are aggregated into one reportable business segment, market pulp. Accordingly, the results presented are those of the reportable business segment.

Certain prior year amounts in the interim consolidated financial statements have been reclassified to conform to the current year presentation.

In these interim consolidated financial statements, unless otherwise indicated, all amounts are expressed in Euros (“€”). The term “U.S. dollars” and the symbol “$” refer to United States dollars. The symbol “C$” refers to Canadian dollars.

Use of Estimates

Preparation of financial statements and related disclosures in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant management judgment is required in determining the accounting for, among other things, doubtful accounts and reserves, depreciation and amortization, future cash flows associated with impairment testing for long-lived assets, derivative financial instruments, environmental conservation and legal liabilities, asset retirement obligations, pensions and post-retirement benefit obligations, income taxes, contingencies, and inventory obsolescence and provisions. Actual results could differ from these estimates, and changes in these estimates are recorded when known.

FORM 10-Q
QUARTERLY REPORT — PAGE 8

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1. The Company and Summary of Significant Accounting Policies (continued)

Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2011-04, Fair Value Measurements (“ASU 2011-04”), which expands the existing disclosure requirements for fair value measurements (particularly for Level 3 inputs) defined under Accounting Standards Codification No. 820, Fair Value Measurement (“ASC 820”), and makes other amendments. Many of the amendments to ASC 820 are being made to eliminate wording differences between GAAP and International Financial Reporting Standards and are not intended to result in a change in the application of the requirements of ASC 820. However, some of the amendments clarify the application of existing fair value measurement requirements and others change certain requirements for measuring fair value and could change how the fair value measurement guidance in ASC 820 is applied. The measurement and disclosure requirements of ASU 2011-04 are effective for reporting periods beginning after December 15, 2011 and are to be applied prospectively. The Company does not expect that the adoption of this new guidance will have a material impact on the consolidated financial statements or related note disclosures.

In June 2011, the FASB issued Accounting Standards Update 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”), which revises the manner in which entities present comprehensive income in their financial statements. The new guidance amends Accounting Standards Codification No. 220, Comprehensive Income, and gives reporting entities the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income in either a continuous statement of comprehensive income or two separate but consecutive statements. Under the two-statement approach, which the Company currently uses, the first statement includes components of net income, and the second statement includes components of other comprehensive income. ASU 2011-05 does not change the items that must be reported in other comprehensive income. This new guidance is effective for reporting periods beginning after December 15, 2011 and is to be applied retrospectively. The Company does not expect the adoption of this guidance to have an impact on the consolidated financial statements or related note disclosures.

Note 2. Stock-Based Compensation

In June 2010, the Company adopted a new stock incentive plan (the “2010 Plan”) which provides for options, restricted stock rights, restricted stock, performance shares, performance share units and stock appreciation rights to be awarded to employees, consultants and non-employee directors. As at June 30, 2011, after factoring in all allocated stock, there remain approximately 1.1 million common shares available for grant pursuant to the 2010 Plan.

Performance Shares

Grants of performance shares comprise rights to receive stock at a future date that are contingent on the Company and the grantee achieving certain performance objectives.

FORM 10-Q
QUARTERLY REPORT — PAGE 9

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 2. Stock-Based Compensation (continued)

In February 2011, the Company awarded a total of 812,573 potential performance shares to employees of the Company, the majority of which vest using a partial vesting schedule between 2014 and 2016; 50% are scheduled to vest on January 1, 2014, 25% are scheduled to vest on January 1, 2015, and the remaining 25% are scheduled to vest on January 1, 2016. There were nil performance shares which had vested, been forfeited, or been cancelled during the three and six months ended June 30, 2011. Expense recognized for the three and six month periods ended June 30, 2011 was €245 and €759, respectively. Performance shares are expensed each reporting period based on their fair value, which is then amortized to reflect the time elapsed in the vesting period. The fair value of the performance shares is determined based upon the targeted number of shares awarded and the quoted price of the Company’s stock at the reporting date. The target number of shares is determined using management’s best estimate. The final determination of the number of shares to be granted will be made by the Board of Directors.

Between February and March 2011, the Company granted and issued a total of 474,728 shares of common stock for performance shares, which were originally awarded in 2008 and had vested on December 31, 2010. Pursuant to the accounting guidance in FASB’s Accounting Standards Codification No. 718, Compensation — Stock Compensation, the Company adjusted the number of performance shares awarded to employees to the number granted by the Board of Directors, and accordingly adjusted compensation cost based on the fair value of Mercer’s common stock at the grant date. As a result, the Company recognized approximately €1,420 associated with the final determination of these performance shares in the three months ended March 31, 2011. The fair value of these performance shares was determined based upon the number of shares granted and the quoted price of the Company’s stock at the grant date.

Restricted Stock

The fair value of restricted stock is determined based upon the number of shares granted and the quoted price of the Company’s stock on the date of grant. Restricted stock generally vests over a one year period, except as noted below. Expense is recognized on a straight-line basis over the vesting period.

During the three months ended June 30, 2011, 38,000 restricted stock awards were granted to directors of the Company (2010 — 56,000). In the three months ended March 31, 2011, 200,000 (2010 — nil) restricted stock awards were granted to the Chief Executive Officer of the Company, which vest in equal amounts over a five year period commencing in 2012.

There were no restricted stock awards cancelled or forfeited during the three and six month periods ended June 30, 2011. During the three months ended June 30, 2011, 56,000 restricted stock had vested. As at June 30, 2011, the total number of unvested restricted stock was 238,000 (2010 — 77,000).

FORM 10-Q
QUARTERLY REPORT — PAGE 10

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 2. Stock-Based Compensation (continued)

Expense recognized for the three and six month periods ended June 30, 2011 was €265 and €396, respectively (2010 — €22 and €24). As at June 30, 2011, the total remaining unrecognized compensation cost related to restricted stock amounted to approximately €1,808 (2010 — €226), which will be amortized over the remaining vesting periods.

Stock Options

During the three and six month periods ended June 30, 2011 and 2010, no options were granted, exercised or cancelled, and nil and 15,000 options expired, respectively (2010 — nil and 738,334). The aggregate intrinsic value of options outstanding and currently exercisable as at June 30, 2011 was $3.56 per option.

Stock compensation expense recognized for stock options for the three and six month periods ended June 30, 2011 was €nil (2010 — €nil). All stock options have fully vested.

Note 3. Net Income (Loss) Per Share Attributable to Common Shareholders

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Net income (loss) attributable to common shareholders — basic		€	14,383			€	12,401			€	43,436			€	4,855
Interest on convertible notes, net of tax			349				747				750				1,437
Net income (loss) attributable to common shareholders — diluted		€	14,732			€	13,148			€	44,186			€	6,292
Net income (loss) per share attributable to common shareholders
Basic		€	0.32			€	0.34			€	0.97			€	0.13
Diluted		€	0.26			€	0.23			€	0.77			€	0.11
Weighted average number of common shares outstanding:
Basic(1)			45,521,094				36,349,340				44,805,877				36,334,846
Effect of dilutive instruments:
Performance shares			107,468				425,668				472,860				429,865
Restricted stock			27,824				22,067				77,946				16,498
Stock options and awards			83,734				—				78,355				—
Convertible notes			11,259,152				20,197,563				11,846,592				20,212,058
Diluted			56,999,272				56,994,638				57,281,630				56,993,267

The calculation of diluted net income (loss) per share attributable to common shareholders does not assume the exercise of any instruments that would have an anti-dilutive effect on earnings per share.

The diluted net income (loss) per share calculation for the three and six month periods ended June 30, 2010 excluded 190,000 shares related to stock options, as the exercise price of these options was greater than their average market value, which would result in an anti-dilutive effect on diluted earnings per share.

FORM 10-Q
QUARTERLY REPORT — PAGE 11

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 4. Inventories

		June 30, 2011				December 31, 2010
Raw materials		€	37,344			€	47,179
Finished goods			37,147				27,127
Work in process and other			29,825				27,913
		€	104,316			€	102,219

Note 5. Debt

Debt consists of the following:

		June 30, 2011				December 31, 2010
Note payable to bank, included in a total loan credit facility of €827,950 to finance the construction related to the Stendal mill (a)		€	486,074			€	500,657
Senior notes due February 2013, interest at 9.25% accrued and payable semi-annually, unsecured (b)			—				15,341
Senior notes due December 2017, interest at 9.50% accrued and payable semi-annually, unsecured (c)			206,569				224,031
Subordinated convertible notes due January 2012, interest at 8.5% accrued and payable semi-annually (d)			24,897				31,707
Credit agreement with a lender with respect to a revolving credit facility of C$40 million (e)			—				15,016
Loan payable to the noncontrolling shareholder of the Stendal mill (f)			32,244				31,365
Credit agreement with a bank with respect to a revolving credit facility of €25,000 (g)			—				—
Investment loan agreement with a lender with respect to the wash press project at the Rosenthal mill of €4,351 (h)			3,263				3,807
Credit agreement with a bank with respect to a revolving credit facility of €3,500 (i)			—				—
			753,047				821,924
Less: current portion			(44,152	)			(39,596	)
Debt, less current portion		€	708,895			€	782,328

The Company made principal repayments under these facilities of €30,351 during the six months ended June 30, 2011 (2010 — €8,250). As of June 30, 2011, the principal maturities of debt are as follows:

Matures		Amount
2011(1)		€	34,023
2012			25,671
2013			41,088
2014			40,544
2015			44,000
Thereafter			567,721
		€	753,047

FORM 10-Q
QUARTERLY REPORT — PAGE 12

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 5. Debt (continued)

Certain of the Company’s debt instruments were issued under an indenture which, among other things, restricts Mercer Inc.’s ability and the ability of its restricted subsidiaries to make certain payments. These limitations are subject to other important qualifications and exceptions. As at June 30, 2011, the Company was in compliance with the terms of the indenture.

(a)

Note payable to bank, included in a total loan facility of €827,950 to finance the construction related to the Stendal mill (“Stendal Loan Facility”), interest at rates varying from Euribor plus 0.90% to Euribor plus 1.58% (rates on amounts of borrowing at June 30, 2011 range from 2.43% to 3.22%), principal due in required installments beginning September 30, 2006 until September 30, 2017, collateralized by the assets of the Stendal mill, with 48% and 32% guaranteed by the Federal Republic of Germany and the State of Saxony-Anhalt, respectively, of up to €433,573 of outstanding principal, subject to a debt service reserve account (“DSRA”) required to pay amounts due in the following twelve months under the terms of the Stendal Loan Facility; payment of dividends is only permitted if certain cash flow requirements are met. See Note 6 — Derivative Transactions for a discussion of the Company’s variable-to-fixed interest rate swaps.

On March 13, 2009, the Company finalized an agreement with its lenders to amend its Stendal Loan Facility. The amendment deferred approximately €164,000 of scheduled principal payments until the maturity date, September 30, 2017. The amendment also provided for a 100% cash sweep, referred to as the “Cash Sweep”, of any cash, in excess of a €15,000 working capital reserve and the guarantee amount, as discussed in Note 10, held by Stendal which will be used first to fund the DSRA to a level sufficient to service the amounts due and payable under the Stendal Loan Facility during the then following 12 months, which means the DSRA is “Fully Funded”, and second to prepay the deferred principal amounts. As at June 30, 2011, the DSRA balance was approximately €28,300.

(b)

In February 2005, the Company issued $310 million of senior notes due February 2013 (“2013 Notes”), which bore interest at 9.25%, accrued and payable semi-annually, and were unsecured.

On November 17, 2010, the Company used the proceeds from a private offering of $300 million senior notes due 2017, described in Note 5(c) below and cash on hand to complete a tender offer to repurchase approximately $289 million aggregate principal amount of its 2013 Notes. Pursuant to the FASB’s Accounting Standards Codification No. 405, Liabilities — Extinguishment of Liabilities (“ASC 405-20”), the Company concluded that the tendering of the 2013 Notes met the definition of a debt extinguishment. In connection with this tender offer and pursuant to FASB’s Accounting Standards Codification No. 470-50, Debt-Modifications and Extinguishments (“ASC 470-50”), the Company recorded approximately €7,500 to the loss on extinguishment of debt line in the Consolidated Statement of Operations which included the tender premium paid and the write-off of unamortized debt issue costs.

FORM 10-Q
QUARTERLY REPORT — PAGE 13

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 5. Debt (continued)

On February 15, 2011, the Company redeemed for cash all of its outstanding 2013 Notes, for a price equal to 100% of the principal amount of $20.5 million, plus accrued and unpaid interest to, but not including February 15, 2011. In total, the Company paid approximately $21.5 million (€15,900) in connection with the redemption of the 2013 Notes.

(c)

On November 17, 2010, the Company completed a private offering of $300 million in aggregate principal amount of Senior Notes due 2017 (“2017 Notes”). The proceeds from this offering were used to finance the tender offer and consent solicitation for approximately $289 million of the Company’s 2013 Notes (see Note 5(b)). The 2017 Notes were issued at a price of 100% of their principal amount. The 2017 Notes will mature on December 1, 2017 and bear interest at 9.5% which is accrued and payable semi-annually.

The 2017 Notes are general unsecured senior obligations of the Company. The 2017 Notes rank equal in right of payment with all existing and future indebtedness of the Company and senior in right of payment to any current or future subordinated indebtedness of the Company. The 2017 Notes are effectively junior in right of payment to all borrowings of the Company’s restricted subsidiaries, including borrowings under the Company’s credit agreements which are secured by certain assets of its restricted subsidiaries.

The Company may redeem all or a part of the 2017 Notes, upon not less than 30 or more than 60 days’ notice, at the redemption prices (expressed as percentages of principal amount) equal to 104.75% for the twelve month period beginning on December 1, 2014, 102.38% for the twelve month period beginning on December 1, 2015, and 100.00% beginning on December 1, 2016, and at any time thereafter, plus accrued and unpaid interest.

(d)

In December, 2009, the Company exchanged approximately $43.3 million of Subordinated Convertible Notes due October 2010 (the “2010 Notes”) through two private exchange agreements with the holders thereof for approximately $43.8 million of Subordinated Convertible Notes due January 2012 (the “2012 Notes”). On January 22, 2010, through an exchange offer with the remaining holders of the 2010 Notes, the Company exchanged a further $21.7 million of 2010 Notes for approximately $22.0 million of the Company’s 2012 Notes. The Company recognized both exchange transactions of the Subordinated Convertible Notes as extinguishments of debt in accordance with ASC 470-50, because the fair value of the embedded conversion option changed by more than 10% in both transactions. During 2010, the Company recognized a loss of €929 as a result of the January 22, 2010 exchange. The loss was determined using the fair market value prevailing at the time of the transaction, and will be accreted to income through to January 2012 through interest expense yielding an effective interest rate of approximately 3% on the January 22, 2010 exchange.

FORM 10-Q
QUARTERLY REPORT — PAGE 14

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 5. Debt (continued)

The 2012 Notes bear interest at 8.50%, accrued and payable semi-annually, are convertible at any time by the holder into common shares of the Company at $3.30 per share and are unsecured. The Company may redeem for cash all or a portion of the notes on or after July 15, 2011 at 100% of the principal amount of the notes plus accrued interest up to the redemption date. During the six months ended June 30, 2011, approximately $7.4 million of Subordinated Convertible Notes due January 2012 were converted into 2,232,417 shares, respectively. Pursuant to the 2012 Notes indenture, on May 16, 2011, the Company issued notice that it will redeem all outstanding 2012 Notes on July 15, 2011, at 100% of the principal amount, plus accrued interest. See Note 11 — Subsequent Event.

(e)

Credit agreement with respect to a revolving credit facility of C$40.0 million for the Celgar mill. The credit agreement matures May 2013. Borrowings under the credit agreement are collateralized by the mill’s inventory and receivables and are restricted by a borrowing base calculated on the mill’s inventory and receivables. Canadian dollar denominated amounts bear interest at bankers acceptance plus 3.75% or Canadian prime plus 2.00%. U.S. dollar denominated amounts bear interest at LIBOR plus 3.75% or U.S. base plus 2.00%. The Company fully repaid this facility on March 30, 2011. As at June 30, 2011, approximately C$2.1 million of this facility was supporting letters of credit, leaving approximately C$28.2 million available.

(f)

A loan payable by the Stendal mill to its noncontrolling shareholder bears interest at 7.00%, and is accrued semi-annually. The loan payable is unsecured, subordinated to all liabilities of the Stendal mill, non-recourse to the Company and its restricted subsidiaries, and is due in 2017. The balance includes principal and accrued interest. During the first quarter of 2010, the noncontrolling shareholder converted €6,275 of accrued interest into a capital contribution.

(g)

A €25,000 working capital facility at the Rosenthal mill that matures in December 2012. Borrowings under the facility are collateralized by the mill’s inventory and receivables and bear interest at Euribor plus 3.50%. As at June 30, 2011, approximately €2,200 of this facility was supporting bank guarantees leaving approximately €22,800 undrawn.

(h)

A four-year amortizing investment loan agreement with a lender relating to the new wash press at the Rosenthal mill with a total facility of €4,351 bearing interest at the rate of Euribor plus 2.75% that matures August 2013. Borrowings under this agreement are secured by the new wash press equipment. As at June 30, 2011, this facility was drawn by €3,263 and was accruing interest at a rate of 4.07%.

FORM 10-Q
QUARTERLY REPORT — PAGE 15

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 5. Debt (continued)

(i)

On February 8, 2010 the Rosenthal mill finalized a credit agreement with a lender for a €3,500 facility maturing in December 2012. Borrowings under this facility will bear interest at the rate of the 3-month Euribor plus 3.50% and are secured by certain land at the Rosenthal mill. As at June 30, 2011, this facility was undrawn.

Note 6. Derivative Transactions

The Company is exposed to certain market risks relating to its ongoing business. The Company seeks to manage these risks through internal risk management policies as well as, from time to time, the use of derivatives. Currently, the only risk managed using derivative instruments is interest rate risk.

During 2004, the Company entered into certain variable-to-fixed interest rate swaps in connection with the Stendal Loan Facility with respect to an aggregate maximum principal amount of approximately €612,600 of the total indebtedness under the Stendal Loan Facility. Under the interest rate swaps, the Company pays a fixed rate and receives a floating rate with the interest payments being calculated on a notional amount. Currently, the contracts have an aggregate notional amount of €426,518 at a fixed interest rate of 5.28% and they mature October 2017 (generally matching the maturity of the Stendal Loan Facility). The Company substantially converted the Stendal Loan Facility from a variable interest rate loan into a fixed interest rate loan, thereby reducing interest rate uncertainty.

The Company recognized an unrealized loss of €2,339 and gain of €9,904 on these interest rate swaps for the three and six months ended June 30, 2011, respectively (2010 — a loss of €4,462 and €11,008), in the “Gain (loss) on derivative instruments” line in the Interim Consolidated Statements of Operations and Interim Consolidated Statements of Cash Flows. Derivative instruments are required to be measured at their fair value. Accordingly, the fair value of the interest rate swap is presented in “Unrealized interest rate derivative losses” within the long-term liabilities section in the Interim Consolidated Balance Sheets, which currently amounts to a cumulative unrealized loss of €41,069 (2010 — €50,973).

The interest rate derivative contracts are with the same banks that hold the Stendal Loan Facility and the Company does not anticipate non-performance by the banks.

FORM 10-Q
QUARTERLY REPORT — PAGE 16

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 7. Pension and Other Post-Retirement Benefit Obligations

Included in pension and other post-retirement benefit obligations are amounts related to the Company’s Celgar and Rosenthal mills. The largest component of this obligation is with respect to the Celgar mill which maintains a defined benefit pension plan and post-retirement benefit plans for certain employees (“Celgar Plans”).

Pension benefits are based on employees’ earnings and years of service. The Celgar Plans are funded by contributions from the Company based on actuarial estimates and statutory requirements. Pension contributions during the three and six month periods ended June 30, 2011 totaled €430 and €894, respectively (2010 — €247 and €399).

Effective December 31, 2008, the defined benefit plan was closed to new members. In addition, the defined benefit service accrual ceased on December 31, 2008, and members began to receive pension benefits, at a fixed contractual rate, under a new defined contribution plan effective January 1, 2009.

		Three Months Ended June 30,
		2011								2010
						Post-								Post-
		Pension				Retirement				Pension				Retirement
		Benefits				Benefits				Benefits				Benefits
Service cost		€	22			€	116			€	21			€	102
Interest cost			373				201				437				202
Expected return on plan assets			(383	)			—				(409	)			—
Recognized net loss (gain)			126				(17	)			115				(81	)
Net periodic benefit cost		€	138			€	300			€	164			€	223

		Six Months Ended June 30,
		2011								2010
						Post-								Post-
		Pension				Retirement				Pension				Retirement
		Benefits				Benefits				Benefits				Benefits
Service cost		€	44			€	235			€	40			€	195
Interest cost			758				409				832				384
Expected return on plan assets			(777	)			—				(778	)			—
Recognized net loss (gain)			256				(35	)			218				(154	)
Net periodic benefit cost		€	281			€	609			€	312			€	425

FORM 10-Q
QUARTERLY REPORT — PAGE 17

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 8. Share Capital

Common shares

The Company has authorized 200,000,000 common shares (2010 — 200,000,000) with a par value of $1 per share.

During the six months ended June 30, 2011, 2,232,417 shares were issued as a result of certain holders of the 2012 Notes exercising their conversion option (see Note 5(d) — Debt). In addition, 358,268 shares were issued to employees of the Company as part of the stock based performance awards and 238,000 shares of restricted stock were issued to the Chief Executive Officer and directors of the Company.

As at June 30, 2011 and December 31, 2010, the Company had 45,828,343 and 42,999,658 common shares issued and outstanding, respectively.

Preferred shares

The Company has authorized 50,000,000 preferred shares (2010 — 50,000,000) with $1 par value issuable in series, of which 2,000,000 shares have been designated as Series A. The preferred shares may be issued in one or more series and with such designations and preferences for each series as shall be stated in the resolutions providing for the designation and issue of each such series adopted by the Board of Directors of the Company. The Board of Directors is authorized by the Company’s articles of incorporation to determine the voting, dividend, redemption and liquidation preferences pertaining to each such series. As at June 30, 2011, no preferred shares had been issued by the Company.

Note 9. Financial Instruments

The fair value of financial instruments at June 30, 2011 and December 31, 2010 is summarized as follows:

		June 30, 2011								December 31, 2010
		Carrying				Fair				Carrying				Fair
		Amount				Value				Amount				Value
Cash and cash equivalents		€	151,795			€	151,795			€	99,022			€	99,022
Investments			230				230				275				275
Receivables			104,235				104,235				121,709				121,709
Note receivable			1,997				1,997				2,978				2,978
Accounts payable and accrued expenses			112,598				112,598				84,873				84,873
Debt			753,047				798,321				821,924				847,875
Interest rate derivative contracts liability			41,069				41,069				50,973				50,973

FORM 10-Q
QUARTERLY REPORT — PAGE 18

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 9. Financial Instruments (continued)

The carrying value of cash and cash equivalents, notes receivable and accounts payable and accrued expenses approximates the fair value due to the immediate or short-term maturity of these financial instruments. The carrying value of receivables approximates the fair value due to their short-term nature and historical collectability. The fair value of debt reflects recent market transactions and discounted cash flow estimates. The fair value of the interest rate derivatives is calculated by discounting the future interest rate payments using a yield curve derived by recognized financial institutions. Investments are recorded at fair value based on recent transactions.

The fair value methodologies and, as a result, the fair value of the Company’s investments and derivative instruments are determined based on the fair value hierarchy provided in FASB’s Accounting Standards Codification No. 820, Fair Value Measurements (“ASC 820”). The fair value hierarchy per ASC 820 is as follows:

Level 1 — Valuations based on quoted prices in active markets for identical assets and liabilities.

Level 2 — Valuations based on observable inputs in active markets for similar assets and liabilities, other than Level 1 prices, such as quoted interest or currency exchange rates.

Level 3 — Valuations based on significant unobservable inputs that are supported by little or no market activity, such as discounted cash flow methodologies based on internal cash flow forecasts.

The Company classified its investments within Level 1 of the valuation hierarchy where quoted prices are available in an active market. Level 1 investments include exchange-traded equities.

The Company’s derivatives are classified within Level 2 of the valuation hierarchy, as they are traded on the over-the-counter market and are valued using internal models that use as their basis readily observable market inputs, such as forward interest rates.

The valuation techniques used by the Company are based upon observable inputs. Observable inputs reflect market data obtained from independent sources. In addition, the Company considered the risk of non-performance of the obligor, which in some cases reflects the Company’s own credit risk, in determining the fair value of the derivative instruments. The counterparty to our interest rate swap derivative is a multi-national financial institution.

FORM 10-Q
QUARTERLY REPORT — PAGE 19

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 9. Financial Instruments (continued)

The following table presents a summary of the Company’s outstanding financial instruments and their estimated fair values under the hierarchy defined in ASC 820:

		Fair value measurements at June 30, 2011 using:
		Quoted prices in
		active markets for				Significant other				Significant
		identical assets				observable inputs				unobservable inputs
Description		(Level 1)				(Level 2)				(Level 3)				Total
Assets
Investments (a)		€	230			€	—			€	—			€	230
Liabilities
Derivatives (b)
- Interest rate swaps		€	—			€	41,069			€	—			€	41,069

Note 10. Commitments and Contingencies

The Company is involved in certain legal actions and claims arising in the ordinary course of business. While the outcome of these legal actions and claims cannot be predicted with certainty, it is the opinion of management that the outcome of any such claim which is pending or threatened, either individually or on a combined basis, will not have a material adverse effect on the consolidated financial condition, results of operations or liquidity of the Company.

Pursuant to an arbitration proceeding with the general construction contractor of the Stendal mill regarding certain warranty claims, the Company acted upon a bank guarantee for defect liability on civil works that was about to expire as provided in the engineering, procurement, and construction contract. On January 28, 2011, the Company received approximately €10,000 (the “Guarantee Amount”), which is designed to compensate the Company for remediation work that is required at the Stendal mill, but it is less than the amount claimed by the Company under the arbitration. Consequently, the arbitration proceeding is ongoing, and there is no certainty that the Company will be successful with its claims. As at June 30, 2011, the Guarantee Amount was recognized as an increase in cash, and a corresponding increase in accounts payable.

Note 11. Subsequent Event

In May 2011, the Company issued a redemption notice effective July 15, 2011 for its 2012 Notes. Subsequently, in July 2011, substantially all of the outstanding 2012 Notes were converted into 11,214,262 common shares at a conversion price of $3.30 per share, and the Company paid approximately $1.5 million of accrued and unpaid interest. The remaining notes were redeemed by the Company on July 15, 2011 at par plus accrued and unpaid interest to, but not including, July 15, 2011.

FORM 10-Q
QUARTERLY REPORT — PAGE 20

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 12. Restricted Group Supplemental Disclosure

The terms of the indenture governing our 9.5% senior unsecured notes require that we provide the results of operations and financial condition of Mercer International Inc. and our restricted subsidiaries under the indenture, collectively referred to as the “Restricted Group”. As at and during the three and six months ended June 30, 2011 and 2010, the Restricted Group was comprised of Mercer International Inc., certain holding subsidiaries and our Rosenthal and Celgar mills. The Restricted Group excludes the Stendal mill.

Combined Condensed Balance Sheets

		June 30, 2011
		Restricted				Unrestricted								Consolidated
		Group				Subsidiaries				Eliminations				Group
ASSETS
Current assets
Cash and cash equivalents		€	86,941			€	64,854			€	—			€	151,795
Receivables			51,854				52,381				—				104,235
Inventories			56,556				47,760				—				104,316
Prepaid expenses and other			6,745				3,944				—				10,689
Deferred income tax			24,928				—				—				24,928
Total current assets			227,024				168,939				—				395,963
Long-term assets
Property, plant and equipment			348,193				475,867				—				824,060
Deferred note issuance and other			6,064				3,869				—				9,933
Due from unrestricted group			84,674				—				(84,674	)			—
Note receivable			—				—				—				—
Total assets		€	665,955			€	648,675			€	(84,674	)		€	1,229,956
LIABILITIES
Current liabilities
Accounts payable and accrued expenses		€	60,071			€	52,527			€	—			€	112,598
Pension and other post-retirement benefit obligations			692				—				—				692
Debt			25,985				18,167				—				44,152
Total current liabilities			86,748				70,694				—				157,442
Long-term liabilities
Debt			208,744				500,151				—				708,895
Due to restricted group			—				84,674				(84,674	)			—
Unrealized interest rate derivative losses			—				41,069				—				41,069
Pension and other post-retirement benefit obligations			23,048				—				—				23,048
Capital leases and other			6,766				4,476				—				11,242
Deferred income tax			14,404				—				—				14,404
Total liabilities			339,710				701,064				(84,674	)			956,100
EQUITY
Total shareholders’ equity (deficit)			326,245				(35,897	)			—				290,348
Noncontrolling interest (deficit)			—				(16,492	)			—				(16,492	)
Total liabilities and equity		€	665,955			€	648,675			€	(84,674	)		€	1,229,956

FORM 10-Q
QUARTERLY REPORT — PAGE 21

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(In thousands of Euros, except per share data)

Note 12. Restricted Group Supplemental Disclosure (continued)

Combined Condensed Balance Sheets

		December 31, 2010
		Restricted				Unrestricted								Consolidated
		Group				Subsidiaries				Eliminations				Group
ASSETS
Current assets
Cash and cash equivalents		€	50,654			€	48,368			€	—			€	99,022
Receivables			70,865				50,844				—				121,709
Inventories			60,910				41,309				—				102,219
Prepaid expenses and other			6,840				4,520				—				11,360
Deferred income tax			22,570				—				—				22,570
Total current assets			211,839				145,041				—				356,880
Long-term assets
Property, plant and equipment			362,274				484,493				—				846,767
Deferred note issuance and other			6,903				4,179				—				11,082
Due from unrestricted group			80,582				—				(80,582	)			—
Note receivable			1,346				—				—				1,346
Total assets		€	662,944			€	633,713			€	(80,582	)		€	1,216,075
LIABILITIES
Current liabilities
Accounts payable and accrued expenses		€	44,015			€	40,858			€	—			€	84,873
Pension and other post-retirement benefit obligations			728				—				—				728
Debt			16,429				23,167				—				39,596
Total current liabilities			61,172				64,025				—				125,197
Long-term liabilities
Debt			273,473				508,855				—				782,328
Due to restricted group			—				80,582				(80,582	)			—
Unrealized interest rate derivative losses			—				50,973				—				50,973
Pension and other post-retirement benefit obligations			24,236				—				—				24,236
Capital leases and other			7,154				4,856				—				12,010
Deferred income tax			7,768				—				—				7,768
Total liabilities			373,803				709,291				(80,582	)			1,002,512
EQUITY
Total shareholders’ equity (deficit)			289,141				(53,073	)			—				236,068
Noncontrolling interest (deficit)			—				(22,505	)			—				(22,505	)
Total liabilities and equity		€	662,944			€	633,713			€	(80,582	)		€	1,216,075

FORM 10-Q
QUARTERLY REPORT — PAGE 22

MERCER INTERNATIONAL INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 12. Restricted Group Supplemental Disclosure (continued)

Combined Condensed Statements of Operations

		Three Months Ended June 30, 2011
		Restricted				Unrestricted								Consolidated
		Group				Subsidiaries				Eliminations				Group
Revenues
Pulp		€	125,238			€	92,036			€	—			€	217,274
Energy			5,701				8,240				—				13,941
			130,939				100,276				—				231,215
Operating costs			100,209				72,326				—				172,535
Operating depreciation and amortization			7,401				6,468				—				13,869
Selling, general and administrative expenses and other			5,301				3,299				—				8,600
			112,911				82,093				—				195,004
Operating income (loss)			18,028				18,183				—				36,211
Other income (expense)
Interest expense			(6,433	)			(9,684	)			1,234				(14,883	)
Investment income (loss)			1,305				65				(1,234	)			136
Foreign exchange gain (loss) on debt			342				—				—				342
Gain (loss) on derivative instruments			—				(2,339	)			—				(2,339	)
Total other income (expense)			(4,786	)			(11,958	)			—				(16,744	)
Income (loss) before income taxes			13,242				6,225				—				19,467
Income tax benefit (provision)			(2,851	)			(767	)			—				(3,618	)
Net income (loss)			10,391				5,458				—				15,849
Less: net loss (income) attributable to noncontrolling interest			—				(1,466	)			—				(1,466	)
Net income (loss) attributable to common shareholders		€	10,391			€	3,992			€	—			€	14,383